You need to understand equity as soon as you are ready distribute stock. The decisions made here will affect your company for years to come.
Here is a guide to help you understand some terms and phrases that frequently come up in relation to equity. If you have a suggestion for one we should add, let us know on Twitter.
Automated clearing house (ACH): A form of electronic payments and automatic transfers that link financial institutions together. For example, direct deposit.
Alternative minimum tax (AMT): AMT is a different way of calculating your tax obligation. If you make more than the AMT exemption amount, you need to calculate both your ordinary income tax and AMT and pay the higher of the two.
Capital gains tax: A tax on the difference between the sale price of an asset (such as equity or real estate) and the price it was originally purchased for.
Cliff: When the first portion of your option grant vests.
Common stock: A type of stock generally issued to founders and early employees of a company.
Employee stock purchase plan (ESPP): A plan that allows employees of a corporation to periodically purchase the corporation’s stock—usually at a discount—through automatic deductions from their paychecks.
Exercise: Purchasing shares of the issuer’s common stock at the set price defined in your option grant.
Exercise price (or strike price): The fixed price it costs to exercise an option.
Fair market value (FMV): The accepted current value of one share of a private company’s common stock.
Golden handcuffs: Financial incentives or compensation given by an employer to retain an employee for a period of time.
Incentive stock options (ISOs): A type of stock option that may qualify for a more favorable tax treatment. Unlike other types of options, you usually don’t have to pay taxes when you exercise ISOs.
Liquidation preference: A stipulation that says if a company liquidates, investors and preferred shareholders will receive their investment first.
Liquidity: The ability to turn an asset (like stock) into cash.
Liquidity event: An event at a company that allows founders and employees to turn their shares into cash. Examples include a tender offer, IPO, or merger.
Lock-up period: A period of time in which those who acquired stock before their company went public cannot sell their shares.
Non-qualified stock options (NSOs): A type of stock option that does not qualify for favorable tax treatment, meaning you pay tax when you exercise.
Option grant: A document that usually includes details like the type of stock options you get, how many shares you get, your strike price, and your vesting schedule. You need to accept your option grant if you want to be able to exercise and sell your stock options in the future.
Ordinary income: Income other than long-term capital gains. Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation.
Post-money valuation: The value given to a company after it’s been invested in.
Right of first refusal (ROFR or RFR): The right of someone to enter into a business transaction before anyone else can. Often, companies retain ROFRs on transfers and sales of their own stock, which adds a wrinkle to some types of secondary transactions.
Restricted stock units (RSUs): A promise from your employer to give you shares of the company’s stock (or the cash equivalent) on a future date if certain restrictions are met.
Secondary stock transactions: Also known as secondaries, these are any purchase or transaction of common or preferred stock that aren’t related to a primary financing event.
Stock dilution: When a company issues additional shares and subsequently reduces how much of the company you (and the other shareholders) own. This usually occurs during a fundraising round.
Stock options: The right to buy a set number of company shares at a fixed price, usually called a grant price, strike price, or exercise price.
Stock split: When a company divides each share into multiple shares. Though the price of each share decreases, the value of the shares as a whole remains the same.
Tender offer: When a company or third party purchases shares from shareholders for a specific price within a certain amount of time. This is often done to increase liquidity for employees and founders.
Trigger: A clause that can accelerate the vesting of options for senior employees. Triggers usually occur during a change-of-control (such as an acquisition), upon termination, or both.
Vesting: The process of earning an asset, like stock options or employer-matched contributions to your 401(k) over time. Companies often use vesting to encourage you to stay longer at the company and/or perform well so you can earn the award.
For companies & founders
Cap table: A list of all the securities your company has issued and who owns them.
Convertible note: When seed investors loan money to a startup and receive preferred stock in return. In short, it’s debt that gets turned into equity.
Data room: A secure location used for storing privileged data.
Discount for lack of marketability (DLOM): An amount or percentage that is deducted from the value of an ownership interest to reflect the relative absence of marketability.
Financing round (fundraising round): An event where a company attempts to raise capital.
Form 3921: A form companies need to fill out if their employees exercised ISOs in the previous year.
Founders shares: The shares given to the founders of a company. These shares usually have different rights than common stock.
Issuer: An entity that issues securities (options, stocks, etc.)
LTM/NTM: Shorthand for last 12 months (LTM) and next 12 months (NTM), often used when discussing revenue.
Option pool: The shares of stock a private company reserves for employees.
Pitch deck: A presentation that summarizes your business. Usually, the goal of a pitch deck is to raise funding from investors.
Rule 701: A federal exemption that currently allows private companies to issue up to $10M in equity to employees without being subject to the more extensive disclosures that are required for issuances in excess of that amount.
Simple Agreement for Future Equity (SAFE): A documented agreement between a company and investor which states that with the investor’s investment in the company, they get the right to purchase stock in a future equity round.
U.S. Securities and Exchange Commission (SEC): The United States federal agency that’s responsible for the regulation of securities markets.
Accredited investor: A person or institution who can invest in securities that are not registered with financial regulators (e.g. private companies). Currently, the rules apply to individuals who have a net worth of $1 million (not including the value of primary residence) or an annual income of $200,000 a year, or $300,000 combined with their spouse.
ASC 820: Stands for Accounting Standards Codification 820, which offers guidance on how to value illiquid assets such as preferred stock in a private VC-backed company.
Capital call: When a VC firm asks a limited partner for money that has been already committed to the fund.
Carry: A performance fee paid out to general partners at a VC firm that is based on the share of profits from an investment or the whole fund.
Internal Rate of Return (IRR): The annualized percent return an investor’s portfolio company or fund has earned (or expects to earn).
Know your customer/anti-money laundering (KYC/AML): Regulations that ensure the integrity of your financial systems, including requiring that only legitimate investors contribute to your fund.
Participating preferred stock: Indicates that preferred stockholders are paid out at the same time that the common stockholders are paid out, in addition to being previously paid out during their payout according to their seniority level.
Preferred stock: Stock that is primarily issued to investors (venture capitalists, angel investors, PE firms) when they finance funding rounds. It is considered less risky than common stock since preferred stockholders get priority on company assets over common stockholders.
Tearsheet: A one-page update about a portfolio company.
DISCLOSURE: This communication is on behalf of eShares Inc., d/b/a Carta, Inc. (“Carta”). This communication is not to be construed as legal, financial or tax advice and is for informational purposes only. This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.
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